Mutual Fund Terms

By BankBazaar | July 28, 2016

Mutual Fund Terms

Mutual Funds are a much-loved investment product. Many investors looking to grow their wealth with a degree of long-term certainty turn to Mutual Funds. There are funds available for a range of investment needs and risk appetites.

But before you invest in any fund, you must accustom yourself to the terms of the business.

MF Unit: A Mutual Fund unit is equivalent to a share in a company. Just as you may hold a number of shares in a company, you will own units in a Mutual Fund. Simply put, this is the lowest quantum of investment you need to make in any Mutual Fund.

Net Asset Value (NAV): Just as stocks have a price, a Mutual Fund has its NAV. It is the value of one unit of a fund. The NAV is calculated by taking the weighted average price of all the assets (such as stocks, bonds, funds, etc.) minus the expenses in managing the fund. Then the value is divided into all the units of the Mutual Fund. This is the price that investors pay to buy a unit of the Mutual Fund. NAV is declared every day and investors can see its value on any financial site.

Benchmark: In case of direct equity investing, you have certain benchmarks to compare your returns with or other parameters of the company and stocks. For example, if you invest in an IT company, you may like to compare your returns with the top firms in the IT sector. In case of Mutual Funds, since they invest in a set of assets, it is compared with a benchmark index. This is generally the case with equity Mutual Funds. For example, an equity fund investing in blue chip companies should be compared with the Nifty index, which would act as the benchmark. A banking fund investing majorly in banks should be compared with the banking index.

Compounded Annual Growth Rate (CAGR): This is the rate at which the NAV of the Mutual Fund has appreciated annually over a period of time. Since NAVs do not grow at a linear rate, CAGR is different every year. It shows you the mean annual growth rate of the NAV (or your investment in general) over a specified period of time and does not indicate an assured annual rate of growth.

Dividend, Growth, and Reinvestment: These are variants of the same Mutual Funds categorised according to how they give returns to investors. A dividend-paying Mutual Fund provides dividends from time to time to its investors. However, dividends reduce the value of the NAV leading to lower capital gains. Growth Mutual Funds do not provide any dividend and the returns simply add to their NAV providing higher capital gains. In case of the reinvestment option, funds use dividend to buy extra units, i.e. reinvest the dividend.

Expense Ratio: Expense ratio measures the expenses incurred to manage the fund. It involves the management fee, administration charges, and any other expenses related to the Mutual Fund operations. It is measured as a percentage of the NAV and hence called ratio. The expense ratio lowers the NAV marginally.

SIP, STP, SWP: Most investors use SIP (Systematic Investment Plan) to invest in Mutual Funds. However, awareness of terms such as SWP (Systematic Withdrawal Plan) and STP (Systematic Transfer Plan) is lower. SWP equates to systematic selling of parts of your Mutual Fund portfolio as opposed to SIP where you systematically buy funds at fixed intervals. STP is the systematic selling of part of your investment in one Mutual Fund and the simultaneous buying of another Mutual Fund every month. Consider, for example, a situation where your gains have peaked and there is little scope for further appreciation. At the same time, you do not want to sell all your bond fund investment and switch to equity funds as of now because of uncertainty in the stock market. In such a case, an STP works wonders.

While there are many more terms in Mutual Fund investment that can deepen one’s understanding of Mutual Funds, the above terms will enable you to take more informed decisions as far as Mutual Fund investment is concerned.

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